Microsoft Xbox Is Winning The Living Room War. Here's Why.

David M. Ewalt
, ContributorI focus on the intersection of games and technology.Opinions expressed by Forbes Contributors are their own.

This story appears in the June 25, 2012 issue of Forbes Magazine.

Cookie Monster wants a snack. Sure, he could have a handful of you-know-whats, but even a Muppet has to watch his waistline. So he decides to grab something healthful. “Maybe if me jump up and down, me can shake fruit out of this tree,” the fuzzy blue monster says to his television viewers. “Okay. Help me jump!”

Muppets have always broken the fourth wall. But for the first time, Cookie can actually tell if kids are responding. When they do, his googly eyes shake wildly and leaves fall from the tree. “Oh boy, oh boy,” Cookie cheers. If the child refuses to budge, he invites his fuchsia friend Telly on-screen to do the jumping instead.

This is Kinect Sesame Street TV, a fully interactive version of the award-winning educational program that goes on sale exclusively for
Microsoft’s Xbox game console in September. The Xbox’s Kinect accessory comes with cameras and microphones and can see and hear the kids as they watch and play. “Kids generally learn through play, and this is an opportunity to get them off the couch and involved,” says Terry Fitzpatrick, chief content and distribution officer for Sesame Workshop, which has produced Sesame Street since 1969. “Microsoft recognized the value of it immediately.”

Don Mattrick, chief of Microsoft's interactive entertainment business, home of the Xbox. Photo: John Keatley/Redux for Forbes

Parents can buy the disc wherever videogames are sold, except to Microsoft this is not a videogame—it’s a TV show you can play. Also on the disc is a version of “Elmo’s World” that films you with the Kinect camera and puts you on-screen with Elmo in real time. It’s fun for kids, but this is a serious salvo in the fight with
Sony,
Apple,
Google and a dozen other players to control your family television. “The living room is very important,” says Microsoft CEO Steve Ballmer in our interview in a conference room just outside his Redmond, Wash. office. Ballmer, in regulation button-down and khakis, spent 30 minutes just on the future of the Xbox. “It’s a place where there’s a high volume of consumption of digital goods and services. So Xbox is very important.”

High-volume consumption is an understatement. Yes, people are spending more time on their computers and smartphones. But watching the tube remains almost a full-time job for the average American, who puts in nearly 35 hours a week, according to research firm Nielsen. And that habit has not migrated to Windows PCs. Ninety-eight percent of view time is still spent staring at a traditional TV set. Americans spend $91 billion a year on cable and satellite subscriptions, and advertisers spend another $72 billion reaching us there. This remains a fat enough cow to move the needle, even at mighty Microsoft.

Click to enlarge the graphic.

So the Xbox has become Ballmer’s weapon of choice, one that his company has aggressively moved to position as something more than a toy used to play a little Call of Duty or Madden NFL. Over the last ten years, while its rivals have dithered and misfired, Microsoft has been feeding its living-room secret weapon a nonstop diet of software updates and hardware upgrades. This spring, for the first time, subscribers to Xbox’s Live online service in the U.S. spent more time consuming video and music than multiplayer games. Globally, the hours spent on Xbox Live have grown 30% year over year, including gaming and entertainment, while video consumption has risen 140%.

In some ways the Xbox is emerging as an alternative for those who want to cut the cable cord. On-demand movies and TV? Xbox can stream more than 200,000 high-definition titles. Premium channels? Game of Thrones rages on via HBO Go on Xbox. Live sports? Xbox has ESPN, every regular-season Major League Baseball game and Ultimate Fighting.

In effect, the Xbox is Microsoft’s profitable Trojan Horse. The console’s latest version, the Xbox 360, is the top seller in the U.S. Worldwide, since the 360 debuted in November 2005, customers have snapped up 67 million units, generating $56 billion at retail. Its sales still outgrow those of all other rivals.

Once installed, Microsoft’s real game begins. The Live service has more than 40 million members in 35 countries. Microsoft makes money selling them points they can use to rent videos or download games. An estimated 17 million Live members pay about $50 a year for a Gold membership, which gets them access to Netflix, HBO Go, ESPN and multiplayer gaming.

In May Microsoft effectively stopped treating Live like an add-on for a videogame console and started pricing the console as a loss leader for an entertainment platform. Rather than pay $199 just for the unit, users can now get an Xbox for $99—as long as they also take a two-year contract to Xbox Live Gold. This new low price looks even better when you consider you don’t need to buy a new TV, which is what Samsung and, soon, Apple want you to do. “If you want to start a phenomenon,” says Ballmer, “it doesn’t start with thousand-dollar-plus devices that sell at unreasonably low volume and need major room redesigns.”